Your Money.

Include Some Glitter In Your Portfolio

The Security That Accompanies Owning Gold Allows Investors To Be More Aggressive With Stocks And Bonds

July 09, 1998|By Jonathan Clements, The Wall Street Journal.

Gold is a lousy long-term investment that could make a great addition to your portfolio.

If you're puzzled by that, you aren't alone.

Like many investors, I have never been convinced of the need to buy gold-company stocks, invest in precious-metals mutual funds or purchase gold coins. But with gold languishing around $300 an ounce, it seems as if the yellow metal deserves a second look.

Not that the lowly price is the reason to buy gold. It just makes the whole proposition more intriguing. Instead, the main argument for owning gold is a diversification argument.

If you are a long-term investor, stocks are your portfolio's engine of growth. But most investors don't want growth alone. They are also interested in easing the anxiety associated with investing and, if they are retired, tapping their portfolio for income.

That is why stock investors buy other stuff, like bonds, money-market funds and gold. These other investments will reduce a stock portfolio's risk level. But this risk reduction comes at a price. After all, over the long haul, none of these other investments is likely to keep up with stocks.

Historically, shares have outpaced inflation by between six and seven percentage points a year. By contrast, bonds might return three percentage points a year above inflation, a money-market fund could yield two percentage points more, and gold prices should roughly match the rise in consumer prices.

Among the array of possible diversifiers for a stock portfolio, I am most drawn to inflation-indexed bonds and cash investments such as money-market funds and Treasury bills. These securities provide a ready source of cash in an emergency, while also offering good bear-market protection.

In a stock-market crash, cash investments shouldn't fall in value and inflation-indexed bonds shouldn't decline much. They could do quite well. Both investments give you a good defense against inflation, which is one of the biggest threats for stock-market investors.

But while cash and inflation-indexed bonds ought to perform reasonably well in a rough stock market, gold has the potential to post spectacular results.

At times of political crisis or accelerating inflation, gold bullion can show huge gains, helping to offset your stock-market losses. Gold-company stocks, and the funds that own them, can fare even better, as soaring gold prices turn marginally profitable gold mines into big money makers.

"If you think about the sort of thing that drives gold higher--inflation, economic chaos, social unrest, war--then people should put 5 percent of their portfolio in gold and hope the price goes down," says Gerald Perritt, editor of Mutual Fund Letter, a Largo, Fla., newsletter.

Perritt continues: "The loss you take on gold is like the premium you pay on an insurance policy. You don't really want to collect on your policy. But it's there just in case."

The problem is, unlike cash investments or inflation-indexed bonds, gold doesn't provide reliable portfolio protection. For proof, you need look no further than the stock-market decline in May and June, when gold funds ranked as one of the worst performing mutual-fund categories.

"We haven't had any inflation, so there's nothing to excite gold investors," says Roger Ibbotson, a finance professor at Yale University's School of Management and chairman of Ibbotson Associates, a Chicago research firm. "We have had political uncertainty in Asia, but not enough to affect the gold market."

But the real value of gold lies less in its actual performance than in the comfort it provides to investors. If you keep some of your money in gold, does that make you more willing to buy stocks?

Suppose you have half your money in stocks and half in bonds. If the comfort that comes with a 5 percent gold position gives you the courage to bolster your stock holdings to 65 percent, with the remaining 30 percent in bonds, you should end up with higher long-run returns.

Of course, this only works if holding gold makes you more aggressive with the rest of your portfolio. That's why I don't own gold. I don't find it comforting. Gold's performance is just too fickle for my taste. But maybe it provides the sort of risk reduction you are looking for. If that is the case, a small stake in gold could make a lot of sense.

Perritt favors two no-load gold funds, American Century Global Gold Fund and Vanguard Specialized Gold and Precious Metals Portfolio. Whatever happens to gold, neither fund is likely to cost you a lot in taxes.

"It's a good idea to use two of them," Perritt explains. "If they continue to slide, you can sell one, buy the other and take the tax loss."